Real Estate: My Favorite Investment Asset Class To Build Wealth

Real estate is all about asymmetric risk and reward. When the government gives you subsidies in the form of mortgage interest tax deductions, a $250K/$500K tax-free profit, and bailouts for overextended homeowners over and over again, you’d be silly not to invest in real estate! When you can invest lots of other people’s money and not have to split the proceeds if you make a killing, that’s a wonderful thing!

There’s a reason why every rich person you know owns multiple properties. There’s a reason why enormous fortunes have been made through real estate as well. How can President Donald Trump still be a billionaire after declaring bankruptcy? Asymmetric risk and reward.

It’s no wonder property owners were once called lords, or now more colloquially, landlords. The wealthy own assets, while the not-so-wealthy lease assets. After 30 years of paying $2,000 a month in rent, your return on $720,000 is negative 100%. At least through a mortgage you’ve got an asset which you can live in rent free or pass on to your children once paid off. You might not make money as the downturn has certainly shown, but at least you have a chance.

When it comes to making money, if there is no risk, there is very little reward. The biggest reason for the widening wealth gap is due to the ownership and lack of ownership in real estate.

Example: Building $1 Million Through One Condo

In early 2003, I put down 20% on a $580,000 condo with a mortgage payment of roughly $2,400 a month at 5.75%. I had just turned 26 and was nervous but adamant I didn’t want to pay more than $2,000 a month on rent. The $464,000 mortgage payment was split $500 to principal and $1,900 to interest. Rent for a comparable property at the time was $2,000 a month, so things were essentially a wash if you include property taxes and deductions.

In 2013, the mortgage rate was 3.375% thanks to several refinances on a loan of $285,000 (from $464,000). I’ve painlessly paid down $180,000 (39% of entire loan) in principal through my PMI loan and the occasional ad hoc principal payments. The mortgage fell to just $1,300 with $500 of it going towards principal. Meanwhile, I was renting the place out for $3,400 a month!

Mortgage interest not only dropped from $1,900 to $800 (-58%) during this time, rent went up from $2,000 to $3,400 (+70%). There are several reasons for this phenomena: 1) Supply is tight in San Francisco due to building restrictions on our 7 mile by 7 mile city, 2) Demand continues to rise due to an increase in jobs from new startups, 3) The economic crisis caused bonds to rise and yields to fall, and 4) The Federal Reserve continues to conduct very loose monetary policy. If you’ve ever deliberated between good location and higher prices or bad location and lower prices, consider the former.

Today, the mortgage is zero because I finally paid the sucker off in 2015 after receiving an influx of cash. I’m now charging $4,400 a month in rent while collecting roughly $3,000 a month in net cash flow after HOA, taxes and maintenance.

My $116,100 downpayment has turned into a cool $1,250,000 15 years later with very little work on my part. For 13 years, my tenants helped pay down my principal. All I had to do was find good tenants about once every two to three years. If I want to sell the property, I can without having to pay any long term capital gains tax due to the 1031 Exchange system which lets me defer or never pay taxes if I find a similar income property within 180 days of sale. Talk about pro government housing!

Rental property mortgage and value history. From $116,100 in equity to over $1,000,000

More Reasons Why Real Estate Is A Great Asset

* Hedge against inflation. You only hate inflation if you don’t have an asset that is inflating. If you own an oil field, a private university, and organic farm, a gold mine, or a rental property, you are loving inflation! Inflation is increasing the prices of your goods hopefully faster than the input costs and the costs to operate your asset. You think rents and prices are expensive now, but I promise you they’ll look cheap 10 years from now.

* A money making play on inflation. Forget about protecting yourself against inflation. Owning real estate is a play on making money with inflation. If there so happens to be hyperinflation, your cash is devaluing rapidly as your real assets start surging in nominal value. Economic tightness will return sooner or later, causing another surge in property and rental prices. Related: Should I Buy real Estate In A Rising Interest Rate Environment?

* Generational wealth transfer. You can pass on property from generation to generation, conceivably making their lives a little bit better. Think about all the college graduates nowadays who are complaining they will never be able to afford a home like their parents due to exorbitant prices. Now think how much worse it will be for their children. If your parents happen to just give you one of their properties, life becomes much less stressful as you don’t need to pay rent anymore! You don’t have to study as hard to succeed either. You can pursue un-lucrative fields such as music, dance, and other fine arts if you so choose because those are your dreams.

* Little effort to build wealth. The most effort comes from researching the property you want to buy and finding the right tenants to pay your mortgage. Once you’ve run various scenario analysis and screened your applicants, you can basically set it and forget it. My average tenant turnover is 2.5 years. I host two open houses for 1.5 hours each, spend another two hours reviewing applicants, and another hour coordinating the move in and that’s it. Meanwhile, to turn $116,000 into $1,000,000 through equity investing is no easy feat, neither is saving another $884,000 over 14 years. The whole idea is to invest in assets that work for you, and not the other way around.

* Tax-free profits. The first $250,000 in profits for singles and $500,000 for couples is tax free if you live in your property for the last two years before sale! If you so happen to be in the top income tax bracket, this is absolutely music to your ears! In order to bank $250,000 in after-tax profits as a top income tax bracket earner, you’ve got to make around $450,000 in gross profits. This special feature alone makes me want to buy property over and over again.

* Serves a utility function. Unlike cash, which serves no utility function, property addresses a fundamental human need, shelter. If our financial system goes to hell, at least you will have a tangible asset you can actually utilize. The only thing I can do with cash is make paper airplanes and perhaps start a fire.

* Semi-passive income generation. Not only do you get to benefit from rising principal values due to inflation, job growth, and income growth, you get to also benefit from rising rents due to the same reasons! I first started renting my rental condo out for $2,300 back in 2005. Now I’m charging $4,200 a month for rent going into 2018. That’s a 83% increase in rent while my mortgage payments stayed the same or declined. You can also potentially earn healthy returns (8% – 15%) that are 100% passive through real estate crowdfunding and owning public REITs. I’m all about taking advantage of real estate crowdfunding to invest in the heartland of America where valuations are lower and yields are higher.

* Almost dummy proof. There were a lot of people who didn’t understand the terms of their loans (neg am, balloon payments etc) or who borrowed way more than four times their income with no savings buffer. Good thing for you, you’re no dummy because you’re reading this article and other articles about real estate investing. Once you run the realistic cost and revenue numbers based on data provided by the seller and comparable properties, you have a base case assumption. If you are achieving a rental yield of 7% and can borrow at just 3.5% after a downturn, your month should be salivating for such a 3.5% immediate spread with principal appreciation potential.

* Measurable wealth. I know that after I finish paying off a mortgage, my net worth will equal the market value of the property. When you invest in private equity, or even public equity, you are taking a massive leap off faith that management and other exogenous variables don’t crush your returns. You pretty much know what you’re going to get in real estate if you follow the course.

* Priceless feeling. There’s something nobody really tells you when you finally purchase your own home. Perhaps because that something is unquantifiable. Even though you likely won’t own the house outright in the beginning, it feels wonderful not to pay someone else’s mortgage anymore. It’s an amazing feeling to be the king or queen of your own castle where you can do what you please. So long as you pay your mortgage, nobody will ever be able to kick you out. You grow roots and finally gain conviction to launch your life.

RINSE, REPEAT, AND GET WEALTHY SLOWLY

I didn’t buy my house with the primary hopes of creating more wealth. I bought my house because I didn’t want to live in a crappy apartment anymore. Here’s my housing expense history if you’re interested with a housing expense framework to help keep your finances in order.

I wanted my own deck, backyard, and freedom to turn up the home theatre system as loud as I wanted. At the age of 28, I wanted to start living a better life after slaving away in the office for the past six years. If I wanted to make more money through real estate, I would have bought a multi-unit building instead. Life can’t all be about making money. Funny how we like to justify our purchases.

Despite economic Armageddon, real estate is still my favorite asset class. For those who are under water, don’t give up hope because everything eventually comes back. Very few other assets require so little work and allow for so much outside funding to create so much value over time. For those who don’t have the downpayment, don’t know whether you plan to live in one city for more than five years, or don’t want to go through the hassle of managing tenants, consider real estate crowdsourcing. I’ve personally invested $810,000 in real estate crowdfunding in order to gain more exposure to the heartland of America where valuations are lower, and yields are higher than coastal city property. The older I get, the more passive I want my income to be.

Renting has its benefits, namely flexibility. But renting itself does not build any wealth. If you are considering investing your money that’s sitting in low yielding accounts, consider investing in real estate. It may be a tough slog the first two years, but in ten years, you’ll probably wish you had bought more!

Recommendations

Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.

Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.

Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.

Less than 5% of the real estate deals shown gets through the Fundrise funnel

Shop around for a mortgage: Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.

Author Bio: Sam started Financial Samurai in 2009 to help people achieve financial freedom sooner, rather than later. He spent 13 years working in investment banking, earned his MBA from UC Berkeley, and retired at age 34 in San Francisco.

Sam’s favorite free financial tool he’s been using since 2012 to manage his net worth is Personal Capital. Every quarter, Sam runs his investments through their free Retirement Planner and Investment Checkup tool to make sure he stays financially free, forever. It’s free and easy to use.

For investing opportunities in 2019, Sam is most interested in investing in the heartland of America through real estate crowdfunding. Property valuations are much cheaper and net rental yields are much higher. There is a demographic trend towards moving away from higher cost areas of the country to lower cost areas thanks to technology.

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Comments

I am in the midst of my property story. But it’s not going as well as yours. We bought in March 2010, and prices have slowly declined . I’m probably underwater, or close to zero. Zillow isn’t a good measure as they have a bunch of wrong info, that I corrected, but they didn’t adjust their valuation. Anyway, we are refinancing to 3.25% next month (hoping is closes on time), but we do plan on being here for another 7-10 years.

Here’s my plan; Pay down to 78% LTV and kick PMI ot the curb (save $325 a month, OUCH!). Assuming the house goes up slowly over the next 7-10 years (we hope), we can then move and rent it out for more than the PITI amount, further reducing our principal. Positive cashflow would be nice, but not necessary. I hope to have that residence paid off by the time I’m 40, and my next house by age 45 or so. Then look into other rental opportunites.

Very vague plan, but that what I’m shooting for. I do agree with all of your reasons above that real estate is still a great investment, and am hoping to play the game myself to build wealth over the years.

I completely agree Sam, it’s just that we may have so many kiddos we need to get more rooms. Although, we cuold add on to the house….but then we wouldn’t fit into our neighborhood, our house would be too big for where we’re at to fetch a good sales price.

You bought your house a few years after the tech bubble pop in 2004, a year into the RE bubble when it started picking up steam in 2003. Would you think it’s a smart idea to buy a house in your area with it heating up like it is now again? What do you think will happen to your rental income if the tech bubble popped again?

He does have a point though, if you check the charts, 2003 is a very fortunate time to buy.
Right at the start of upswing after the tech bubble burst / 9-11 effects. House prices have not returned to such a price level since: (Purchase-only House Price Index of the last 12 years- .

Not to knock that you got a great investment out of it and have managed it well since, but there is an element of luck to the performance of your purchase. (Good time to purchase, decline in mortgage rates since, boom in rental properties needed in SF in the last few years).

I agree with the other posters; you are very lucky and smart to buy at the time. Everything fell right after your purchase to make it a great investment. If you waited just 2 years afterward, you would barely break even or even at loss. Or buying right now; it’s tough to say whether it’s a good investment.

Since I’m playing devils advocate here; if you had invested 10k into apple stock in 2003 when everyone was scared of tech, you would have generated over 600k from each 10k you invested! So you take the down payment you had ~115000 invested in Apple and you would have $6 million and that’s through the biggest decline we had since the great depression and including Apple’s 40% drop from 2012!

Investing in real estate or stocks both takes quite a bit of luck and patience but I like the outlook from stocks for longish term, ie. 30 years. I know because I have a rental and the first year, I paid ~20k for repairs. New roof, maintenance, AC, etc.

Dan,
This is a very incomplete analysis of real estate vs. stock investments. Apple was the stock of the decade — literally, that’s what it was called. It outpaced everything. To make a point that by putting a heap load of cash on just one stock, the lottery winner of stocks and the greatest gainer over the decade, is unrealistic and unbalanced. That’s 20 / 20 hindsight. This is in no way a fair comparison of real-world real estate vs. stocks. The exact opposite case could be made if one invested in Enron pre-November of 2001, and trust me, a lot of people did and lost everything.

Let’s go with averages, which is much more responsible. If one invests in a well performing mutual fund, then one might expect around an 8% to 12% yearly return on investment. If you got lucky and invested in a handful of individual stocks, and several did quite well, then a good ROI would be around 14 – 17%. This is already not typical, year over year, but near exceptional.

Investment property, on the other hand, according to the Wall Street Journal’s Complete Real Estate Guidebook, typically offers around 40 – 45% ROI, due to the combination of 1) property appreciation, 2) principle paydown, 3) positive cash flow, and 4) investment property tax breaks (i.e. the power of tax deferrals, etc.). I own 3 rentals and a homestead myself, and I can tell you that these high ROI numbers are consistent with my experience. Like the book says, when you hold on over time, through the ups and downs and keeping the properties occupied, the investor should always do very well and these numbers will usually play out.

So, typically, as the book says, one can expect 3 to 5 times better in real estate than stocks and/or mutual funds.

A common strategy is to have a mix. Get as much rental property as you can, while investing in (and maxing out if possible) your 401K or IRA, and also some individual investments. Another strategy for the more aggressive investor is to refinance your properties, assuming they have increased in value which they typically will over time, and take as much cash out, to use for more investments or stocks (which uses as much of the bank’s money to make you money). This is called wealth cycle investing and it can work wonders, though not for the faint of heart.

This is a reply from an amateur investor. I literally know nothing about investing – in anything. I CAN, however, tell you that I have lost my butt a few times in the market by trying to pick the winner or even a winning mutual fund. The stock market may be a good place for savvy investors but a horrible place for uneducated investors like myself.

I can without a doubt say that even without any knowledge of the industry, and without any specific instruction from anyone other than my Realtor, I have made a boatload of cash in real estate. Down payment, monthly payment (which is less than rent right now), and taxes insurance etc. I have seen my investment shoot through the roof over the past 2 years. I have literally made almost 100,000 dollars in 2 years.

I lost 40,000 in the stock market. In my opinion, as an amateur, is… if an amateur can do it and make this much money, why not.

It’s better than the stock market here savvy investors prey on the uneducated ones. Market Movers take and those who don’t know too much get taken from.

Great article, Sam! I also agree that real estate is an amazing asset class. I think the toughest thing for me would be coming up with the 20% down payment for the rental property. Would you recommend withdrawing from ROTH IRA (contributions only) to fund the down payment? The Roth IRA is just a side thing for me, as my 401k is my primary retirement account. Let me know what you think.

No rule against Bank Of Mom And Dad paying the downpayment. In fact, this is becoming more common place for younger folks nowadays given the price of property, and the wealth accumulated by our parents.

I can’t tell you how many times I see parents attend open houses with their child here in SF. It used to be competing Mano y Mano. Then it became a competition between two working couples. Now it’s a competition against Multi generational balance sheets!

Actually, it’s the opposite. We had to obtain a “gift letter” indicating that we would NOT be paying them back, because then it would be considered debt, and would change our debt-to-credit ratio, thereby disqualifying us.

I think the average investor is way to scared to jump back in. I think those that are more educated can see that there is real opportunity. Everyone else will soon to follow but it hasn’t happened quite yet. One of the biggest obstacles is still the high unemployment rate. People are still scared about losing their job and not being able to find anything else.

Ouch this is way below your usual standard! First off too simple, you got lucky, bought in a good area at a time when prices were low, but lighting doesn’t usually strike twice. My sister in law did the same as you and for simular reasons, except thier place turned out to be a total nightmare (triplex) first off cash flow negative, secondly the moment it closed the inspector showed up with a long and expensive list of grandfathered repairs, then a nightmare tenant, took 3 months and thousands of dollars to evict, and I could on and on. They’re hoping to have it paid off by the they retire in 10 years. Both have said they wish they had followed my advice and done a bit more research.

A mornings worth of research would have showed them that being a landlord in Ontario Canada is the fast way to bankruptcy, like the one lady who got a professional tenant, 10’s of thousands in dollars in lost rent before they were finally evicted.

This doesn’t mean your wrong, I know a few people who have done well but mostly because they got lucky and bought when prices were low and were smart.

Note: while my comment sounds like sour grapes it’s not meant to be only that Real Estate is the most emotional of all assets, and the numbers have to make sense.

BTW my nephew bought his place his with help from his Dad and rented out all the rooms and more than covered his mortgage. It was also a fixer upper and he (no longer) a contractor was able to do a lot of his own work

Sam, you had $116k to spend on a downpayment at age 26. You were lucky before you even bought the property. Either your family paid for that or you got an extraordinarily high paying job from a young age. Very few people have that sort of money at that age. Lots of very smart, hard-working people will not be able to make such a downpayment at that age.

I also think it is quite deceptive for you to write an article which talks about *only* the positives of investing in a rental place with not even a single sentence paid to the negatives and everything that could go wrong.

Sam may have gotten lucky in this instance, but the principles of wealth building through real estate that he discusses are sound. The second time around he’ll obviously put more thought into making a wise investment based on what he’s learned. Sounds like your sister-in-law didn’t do her research (cash flow negative from the start? a long list of needed improvements that weren’t disclosed in advance? didn’t screen tenants well?). Anyway, I don’t mean to bash your SIL, but those are all amateur mistakes (and yes, I realize those things can and do happen to pros too, once in a while. But it’s clear they are all issues that a little more upfront care could have avoided).

Right on Jeremy! The biggest savings you can have is through the initial negotiations. Be aggressive, and care the least.

I used the tie up of $116,000 in this property to motivate me to work harder and find new sources of revenue. Buying the property also gave me renewed vigor at work, b/c at the time, I was wondering “what’s the point of working so hard” when I’m not spending my money on anything.

Buying the property allowed me to not only live in a better place after my 1 bedroom rental, but also build wealth over time and give me more purpose to work.

It’s not easy building your own business, but it will never happen if you don’t try.

Just a question, What type of job did you have at 26 (0r 20) for that matter to be able to “Save” $116,000 by that age AND, “save aggressively” while paying such a high mortgage payment for 2 years. For someone who only makes 60,000 per year, saving 116,000 seems impossible, even with a mortgage of only 1700.00 (including everything). Most of the statements you make in your article seem true but I guess you have to have money to make money. Are there any suggestions for a lesser paid individual to try to follow in your footsteps?

Thom yes – SPEND LESS is the key, for if you continue to ramp up your spending each time you get a raise you’ll never save anything. Track your spending as Sam suggests at the end of this article so you know where your money is going, and LIVE FRUGALLY for if you make $70k a year and spend nearly $68k of it with fast food instead of packing your lunch, paying others to make coffee for you, buying a bigger car/truck than is needed etc; then your own choices aren’t (yet) saving you what’s needed to escape fiscal slavery. ref book; “the millionaire next door.”

In your question you’ve focused only on Sam’s income… but, one must also focus equally on one’s own total, including everything, spending.

But; it’s a good thing you’re reading this site! Knowledge is power you’re on the right track. Keep making good choices… track your spending… and we’ll all be successful together. See you on the beach!

I love real estate too! It helped me achieve financial freedom, but I chose to invest in income property. If you don’t mind moving every few years, residential real estate can be a goldmine. The $250/500K tax exclusion has no limits.

Thomas – I won’t recommend one house vs. the other, but I’d encourage you to re-examine your thinking on all the interest you’d be paying. Paying $200k in interest over 30 years does NOT make your $350k house really cost $550k. The time value of money is an incredibly important and evidently overlooked factor, especially when you’re dealing with such a long period. First of all, if you had $350k to pay for the house today, you’d be throwing away all the investment opportunity that $350k of cash brings all to save 3.5% interest. Second of all, inflation over 30 years will gradually eat away at the actual value of the money you’re paying to your mortgage (including the interest), while your property gains value to keep up. In other words, in today’s dollars you may only pay $100k (pretend number) in interest. I know this kind of thing may seem like voodoo economics, but it is truly and honestly CHEAPER for even a mildly disciplined individual (financially speaking) to get a 30-year mortgage at these rock bottom rates than to try to avoid paying mortgage interest by paying cash upfront (or prepaying the mortgage).

This article accentuates all the positives of owning investment property with none of the negatives (there are too many to list). I bought a multi-family in 2009, and am just now having positive cash flow. I learned a lot of lessons the hard way, but isn’t that the way most lessons are learned?!

The number one piece of advice I can give to newbies is to understand the most important rule in investing in real estate: you make money buying houses, not selling them. I can’t overstate this enough. There is only so much you can do with a property you dramatically overpay for

You make a good point about it taking a lot more properties (and thus tenants) in a cheaper market to match Sam’s one property in San Francisco. However, that also opens a lot of doors. First of all, most people don’t have $116,000 for a down payment. Second, when Sam loses his single tenant, he loses ALL of his cash flow. If he gets one bad tenant who trashes the place and he has to evict, it’s going to cost him a heck of a lot. Third, it’s a lot harder to save up to buy more places to build a portfolio, whereas with cheap properties it’s relatively easy to pay off one mortgage in order to free one up under the Fannie/Freddie limits. Fourth, cashing out requires cashing ALL out, whereas if you have 10 cheaper places you can sell one or two as cash needs (or better investments) arise.

In my experience, it seems that real estate investing is actually MORE common/popular in low-to-mid-cost areas. Plus there are a lot more low-to-mid-cost areas than high-priced areas around the country.

We only started in 2010, so I can’t comment for myself on 10 years. We’ve bought 3 ~$100k SFHs in the past 2 years, all of which are currently rented with their first tenants (no turnover yet). They’ve all been cash flow positive from day 1, values have been relatively constant or perhaps even dropped small amounts (irrelevant in our opinion). While we know we’ll have harder days than anything we’ve experienced so far, we also know that these properties will be successful long-term investments based on the fundamentals and the purchase prices.

We had some coaching early on from friends and relatives who have invested (and continue to invest) in many forms of real estate for 3 decades with very good success, and continue to consult with them when faced with difficult decisions.

It may be worth having a mix of cheaper rental properties and some that are in popular areas such as San Francisco. Can I ask which part of the country you are in, Jonathan?

I currently have 4 homes that were bought on hard money, fixed up (10-25k repairs), refinanced, and rented out. Each took about 20k on average (ranging from 12k – 28k) of my capital to acquire and they all cashflow about $350/mo BEFORE maintenance and vacancy. You can see I can get about 5-6 homes here in Texas with a capital amount of 116k. However, you do run into the problem of running into a loan limit. Yes you can pay off mortgages but I would rather spend my capital acquiring new properties and keeping them financed (8-15% return on capital) rather than paying down mortages (only 4-5% return depending on interest rate).

There are advantages and disadvantages for cheap rentals and expensive rentals. Yes, if Sam only had one rental in SF and lost his tenant, he would lose all of his cash flow. However, because it’s a popular and expensive area, he will have no problem finding another tenant within a few days. In Texas, I can have multiple properties on the MLS for over a month. Cheap rentals are more stable and predictable, but they will never have the potential to appreciate in value by 200k+ like homes on the coasts. I like to think of it as similar to growth stocks (high capital gains) vs. dividend stocks (stable, income producing). It’s good to have both, the only problem is you can only be in one place at one time! Luckily I have a lady friend in SF who may help scope out the market over there…

James – Southern California. I agree, a nice mix of higher- and lower-priced properties would be nice. Incidentally there is still the potential for $200k returns…these houses sold for $250-$300k brand new 6 or 7 years ago. While we’re not counting on the values shooting back up to those levels anytime soon, it could happen.

The vacancy rate for my rental over the past 8 years has been 0 days. In other words, no vacancy. Tenants have paid for a full month and have moved out before the month is over twice. They give me a 30-60 day heads up, and I put up an ad on CL for two open houses while they are still there.

When you buy in a good location, the demand is always very strong. I highly suggest people go for location, and quality over less desirable locations.

Think being at the top of the pyramid where the base of demand gets wider and wider.

As you know I too dabble at the low end of the market. My goal is to have a minimum of 10 units, preferably all in multi-unit properties. I’m actually in the process of looking at property #3 right now. I am purchasing at a rate of 1 property per year because of everyrthing that you mentioned, plus the benefits of having such a low entry point due to lower priced homes.

This is how I plan on retiring early. My homes are typically cash flow positive from day one with a total payback period of 3-4 years. After that the homes are mine, free and clear. Except for one nightmare tenant, it hasn’t been bad.

I also agree that you make your money when you purchase the homes. One bad deal can cripple the financial prospects of the property.

Sounds like a great plan! Just know that banks are very stringent on giving out mortgages if you decide to quit your job as you mentioned. Hence, either buy all you can before you quit or continue paying cash.

We own two rental homes and I love them for all of the reasons you listed! I understand them and how I am making money from them. I can feel them, see them, walk around in them. To me, they are more “real” than my other investments.

We have had some shenanigans with nightmare tenants before….but overall, its worth it!

And even when you screen people well, stuff still can happen! I wrote a story about owning rental property that will be published at Get Rich Slowly TOMORROW. Make sure to check it out. I anticipate people being really, really mean to me =)

A little late to the party, but I’m a bit confused on some of your math… while I’m not questioning that long term this has been a good win for you – you said:
“The $464,000 mortgage payment was split $500 to principal and $1,900 to interest. Rent for the property at the time was $2,000 a month, so things were essentially a wash if you include property taxes and deductions.”

If rent was $2000, principal $500, interest $1900, how exactly did taxes and deductions make it “a wash”? Our understanding is that 1 – there is no mortgage interest deduction for rental properties. 2 – RE taxes are only deductions in as much as they can be counted as an an expense against the net rent.

Unless you’re leaving out huge refundable tax credits (or maybe I’m still half asleep) how was this a wash in the first year?

Owning rental properties in NYC is a NIGHTMARE. The landlord-tenant statutes are extremely tenant friendly. The lady who owned the house next to me lost her home because tenants were allowed to live there rent free for over 6 months. The city would not evict them until I kept calling the health department about their uncut lawn and PILES or garbage bags.

I think one of the biggest reasons real estate is such a strong wealth-building tool is leverage. You can deploy 5:1 leverage on your money, and as long as the property is cash-flow positive, you’re in great shape. You can do that deal all day (or until your funding source runs dry).

I agree with the leveraging. The market will fluctuate over the short term but the value should rise over the long term. Even if you are underwater now, in 10 years, it should come back. I love real estate investing too and most of my after tax investment is in rental properties. I’m looking forward to you stock investing post.

I am itching to get into the rental world. That is probably going to be my next purchase after we sell our current home and buy our next main residence. I would keep the current home as it is a townhouse and PERFECT for renting but the rules prevent me from doing so.

I go back and forth on getting a partner – Sam do you have any experience with that?

You fail to speak about the hardest part of being a landlord – namely tenant selection and management. Its been my experience that a great many people look good on paper, but are slow or no payers, or fail to take good care of the property once they become a tenant. Even checking credit and references is imprecise; many prior landlords just want them out and will give a good ref.

It is often said that location, location, location are the top determinants of real estate value. Don’t forget that 3 factors affecting the success of being a landlord are tenants, tenants, and tenants.

All in all, I agree real estate is a fantastic asset class, but I’ll stick with REITs!

Ok, I get it. There’s enough demand for your properties that you’re able
to treat the tenant screening process as if it were a job interview. In fact, I
think you screen tenants more than many employers screen their applicants.
That works only in a sellers market for high end rental real estate, which it
sounds like you have.

You don’t get exceptional returns from REITs, its a lower return proposition
with correspondingly lower risk. I guess that’s where I feel comfortable sitting
on the so-called “efficient frontier” of real estate investing, sounds like what
you’re doing works for you, but beware the black swan of one bad tenant,
one expensive repair, etc. that could trash your strategy’s returns.

I love this strategy Sam and I have been working on this myself. I have my own condo, which I live in, and I have been saving up for a second down payment. When I move, I plan to keep my place and rent it out. I have a low monthly payment and it is a high rent neighborhood, so I can easily make $500-$700 per month in profit once I move out.

I think real estate only works well if you take out a loan at a decent interest rate and have time to let your renters pay your mortgage off for you.

Hubby doesn’t like loans and if I take one out, he pretty much automatically gets put on the hook to pay it off if I kick the bucket. I’m 63 and don’t have time to wait for the income or appreciation. Taxes and maintenance and marketing all take time and money on a property – and then there is also the added liability.

You present a strong case and a lot of people have made money with real estate. Other’s have lost it…..

Marie, you make a great point about age. Given we have finite lives, RE investing works better for those who have the time, energy, and patience. Therefore, one can make an argument that building a real estate portfolio is best before that age of 45.

I agree that real estate is the fastest way to build wealth overtime. However, I feel that too many people promote the benefits of real estate and don’t promote the negatives that one can encounter. How does one deal with a property that is vacant? Or a tenant that doesn’t pay and destroys the property?

I am already getting exciting about real estate investing. I am buying into a real estate limited partnership as well as making plans for my first home to be a two-family home. Not only are they more house for less money, but they also provide me with a way to build equity with paying a lower portion of the mortgage.

Have you thought about pulling out some of your equity in your condo since it is renting for so high? You could use the equity to buy another property (down payment at least) and rent it out as well. Then, you have two properties increasing in value at the SF rate. what do you think?

I’ve thought about it, but don’t want to borrow to borrow more money. Although things are recovering now, I like to start new purchases with money I’ve earned NOT from previous property. This way, it keeps me motivated to focus on other income streams, and keeps me disciplined from blowing myself up by stretching too thin.

I love property for the reasons mentioned in this book. However, right now, I’m dedicating my time to online endeavors now b/c now is my window. I don’t know if readers other than bloggers will care, but I may write about online income in the future.

I have an offer out on my third property right now. I have 15 year financing already locked up but now I just changed my mind and will go with the 30 year fixed mortgage. In fact, if I use Quicken Loans I’ll be sure to use the link in your post. ;-) #bloggerlove.

We used Quicken to refinance one of our rental properties this year and it was hands down the easiest refinance I have ever done. I submitted all of the paperwork I needed to online and they even came to my primary residence to do the closing. Everyone I talked to on the phone was professional and helpful. I would definitely do it again!!!

Real estate can be a great investment if you’re fully ready for it. One of my friends got in too soon. She wasn’t settled financially or career-wise and had to relocate for work less than a year after buying a condo. She wanted to sell before she moved but couldn’t get it done and it’s been stressful for her.

Great article Sam. I am a big fan of investing in real estate also. I live in the SF Bay Area as well and I work in the real estate industry. One issue I had with your posting is I didn’t see any mentioning of your HOA fees. I have worked on many condos in SF and I know a typical HOA fee will range from $400-$700/mo. while some of the higher priced condos can have HOA fees that exceed $1,000/mo. I am wondering how this affected your overall returns. For many of us starting out in real estate investing and landlording, condos may seem to be an easier way to start off since the mortgages are typically lower than a single family or multi-family residence. But the HOA fee’s for condo investing must be addressed before moving forward.

If you did already address this in your article please forgive me as I was reading it on my phone. But I didn’t notice any mentioning of your HOA fees and how it affected your returns. Thanks!

My HOA is lower than $400. I didn’t want to get bogged down in the mathematics of it, but at the time of purchase, my HOA was $230. So $230 + $1,900 interest + $500 monthly property tax = $2,630 compared to rent of $2,000. Take 70% of $2,630 to get my cost of ownership of around $1,840 + the amount of interest forgone from the downpayment.

This is why I say it’s essentially a wash compared to $2,000 a month in rent when I first bought.

Thanks for the comment Sam. An HOA of $230 is really good for SF. I am not sure which district/neighborhood you bought in but I haven’t seen HOA’s that low in awhile. My cousins bought condo/lofts in the SOMA area around the same time you purchased and their HOA’s were both over $400 and it continued to rise and it became a major complaint by them.

Few questions for you Sam. We bought a property in NyC in 2007, put 20 percent down at 6.25. But refinance rates in nyc are so high (approx 7k) that we only refinanced once to 4.625….so we pay 2200$/mth. We have about 340k left on our mortgage and could rent this place out for 3400 or so, but not sure it’s worth it after paying taxes on the rental income. We have talked about paying off a chunk of the mortgage with our savings that are sitting in the bank but that will only lower our mortgage by a few hundred dollars. It seems it would be more beneficial to put that money towards another down payment. If you had say 50k to “spend” would you put it towards your mortgage? Or maybe invest in another property (but def not in nyc as 50k won’t get you far here)? I feel like we are sitting on this money and should be doing something with it! Any help is welcome.

Is there any one who is investing in real estate properties who don’t live in the particular state? or working out of the USA? Or just working 60-80 hours a week and still make time to deal with they’re properties through management companies? Interested to know because I spend 80-90% of the year out side of the US. And I am trying to figure out is there away I can get a property and feel safe if I have a property management company handle most of the work of finding tenants, deal with maintenance issues and anything else that might arise while I am away…

I tend to shy away from real estate during a boom like this since prices are high due to loose ecenomic policy. Economic tightness would lower prices and leave you with an underwater mortgage. It’s better to buy when prices are lower and mortgage rates are higher then refinance when rates go down.

Is it better to rent in the south bay area than to buy? At this time the prices for condos in mountain view, Santa clara and sunnyvale are already pretty high so it makes it difficult to buy. do you think it is still a good time to invest in real estate? what if you rented out the property right off the bat? would that still be valuable?

Congrats on getting more rental property. The formulas for a great rental purchase differ among cities for sure. If you can get a 12% yield, I’d be buying all day long. But those properties are generally cheaper, and in more difficult neighborhoods. No free lunch!

The problem is you are assuming everything goes well and ignoring the downside risk. What happens if, for example, we have another real estate crash, or the neighborhood becomes less desirable and rents become more modest or stagnate, or what happens if you get a nightmare tenant?

Your entire argument essentially hinges on assuming that both rents and prices will rise faster than inflation forever (and in case you got the memo, it was the exact assumption you are making that crashed our economy 7 years ago!)

There are no guarantees in life, except for renting, which guarantees you a 100% negative return every single month. Oh, and taxes and death too.

Are you a renter or homeowner? If you are a renter, I strongly encourage you to find some place where you would like to settle down and buy. Inflation is just too difficult a force to overcome over the long term.

Rent vs. ownership is apples to oranges. Either you compare ownership to renting and investing the difference (in which case neither is a -100% return), or you compare renting to net present user cost of ownership (in which case both are a -100% return).

I have no reason to take advice based on this type of flawed argumentation.

Hi Highvid Cole,
My experience is that those who potty mouth real estate investing are people who don’t own real estate and they are just justifying the status quo in their lives, or they bought and had to sell early on a downturn, and were either unable or unwiling to hold on to the property to allow appreciation, principal pay down, and tax advantages to work for you.

There is a plethora of data out there available that supports that investment properties are typically a great investment, returning a yearly ROI of 35 – 45 %, as long as you hold on for the long term. And home ownership is great, too, as long as you are not biting off more than you can chew and is within the realm of what one would be paying for rents.

If the market is efficient, owning your own business should give you roughly the same result as working for a W-2 income and investing the difference in passive mutual funds.

Money put into a small business really should be thought of as venture capital – and published rates of return for venture capital funds aren’t all that great considering the large risk being taken on.

These posts are very interesting! I currently own an auto sales business in upstate New York where cash is king. I use my own money to reinvest into buying and selling vehicles. I’m currently paying 1000 a month in rent and I’m located off the beaten path (terrible location). I want to own a commercial property! I just came across an opportunity to purchase a building listed for 125k- after speaking with the motivated seller he would take $100k and hold financing at 5.5 percent interest with 10k down. I’m hoping to have him hold the note for 10 years and have it paid off. My monthly payment based on 10 years would be 950 per month+ taxes ins and common area maint. If I paid off in 5 years it would be $1500 nnn. I will also have to invest approx 30k into fixing up the property but will considerably raise the property value. I’m wondering if I’m foolish to not going conventional financing for a 20 yr term. Banks will most likely require 20 percent down etc. Do you have any recommendations?

Do you think I’d be better off going conventional? Hear me out for one second…the list price on the building is 120 and I’ve negotiated him down to 100 and having him hold the note for 10 years at 5% interest. He will be making around 20,000 in interest over that 10 year period. I’m basically giving him full asking price for 0% interest- that’s the way I’m looking at it. Also Instead of coming up with 20 to 25% down on a conventional mortgage I will essentially be come up with nothing down applying the opm principle. However the building is in need of repairs and could cost approximately 30,000. So instead of giving the bank 20 to 25% I can reinvest it into the building. The payments would be $1000 a month +500 for taxes and cam. This would be my first commercial property purchase so please feel free to make any suggestions

Question. I live in a very large home on the waterfront (bluff) in anchorege, ak. Our kids are grown and i was going to sell it but then i thought to make it into s triplex and we would stay in our part. Only id probably need about 200k to get the 2 other high end units with incredible views ready to rent out st 3k/month. I still owe 590k. Who would loan me the money? Banks dont seem to want too! But if i was buying the place i could get the money. In a 203b loan or construction loan….they wont loan anything to me now i already own it. This would be a fantastic opportunity make money and pay this off in 15 yrs! or less if we put even more money in per month!

While I appreciate real estate vs. stock investment arguments since I enjoy both sides of the argument, your story isn’t a very realistic example. You bought low in San Francisco, and that turned out to be a booming real estate market. It’s far from the norm – look at the flip-side and see how many people are under water on their homes. You basically *got lucky*. The market could’ve tanked and you’d be paying $2,400/mo + property taxes + maintenance + depreciation whereas you could’ve just paid $2,000/mo for a place to live/rent and come out far ahead of where you are now. I think it’s an unfortunate example to use because I’m reading the comments on here and all of these people seem to think it’s completely feasible to buy a place for 580k, rent it for 3.4k/mo, and then sell it for 30% more later on. There’s a reason why every major city is absolutely saturated with foreclosed rental properties, and it’s not because the profits on them are booming.

What you’re saying is akin to me talking about my stock experiences – I purchased into Tesla when it was ~$40/share and sold it when it was a bit over $210/share. Is that a good example for why stocks are better than real estate? Not really, just happened to be a fortuitous experience for me. Overall I’ve averaged about 12% yearly returns in the stock market, so nowhere near my Tesla experience, but fairly good for a completely passive approach to investing. I’m very interested in trying out some real estate investing, but I’m not hedging my bets on whatever market i invest in to turn out like san fran did.

I believe strongly in real estate as an investment towards real estate the negative correlation with bonds and equities is attractive additionally the inefficiencies in the real estate market allow for value plays not available elsewhere. I wonder what your thoughts are on allocation…. would it be irresponsible to allocate 50% of a retirement portfolio dedicated to real estate maybe 15% to direct investment and the remaining to REITS and limited partnerships to allow for some diversification. I would love to hear your thoughts on the matter.

After years of investing in stocks and mutual funds, I finally took the plunge and purchased my first rental property (a duplex). It’s articles like this that make me realize how real estate can be a powerful wealth building asset. Thanks for sharing this.

I wanted to ask a question regarding how to choose a market where to buy real estate.

I currently have $100k liquid (sold everything before Bretix!) and instead of buying VTI next week I’m thinking of going into Real Estate. I have the credit to buy up to $600k, thinking of buying a multi-unit in some market.

How do you choose your market? I was thinking Vallejo (close to SF, ferry to SF in 1 hr, electric vehicle factory in 3 years, bankrupt a few years ago). But this would be my first investment property (already own a house in the peninsula) …

Thanks Sam – I already bought a house in the peninsula where I will be for at least 5-10 years. But now I want to buy ANOTHER property for investment. I don’t have the downpayment (or leverage) to buy another in the area I currently live in – max I can spend for a property is $500k (I was wrong, thought it was $600k) and a 2/1 here is ~$700k.

I recently found your site & really like what you’ve done here. Congratulations!

I’m also glad that you’ve discovered the power of real estate as an investment class. Many of the other financial bloggers focus purely on investing in mutual funds and I think they’re missing a BIG opportunity not only for themselves but also an opportunity to educate their readers.

As a broker I’ve been privy to many hundreds of deals and I’ve had close-up views of exactly who the winners have been.

The winning investors have been those that have invested in commercial land. It was not even close. Their investments grew faster than any of the other real estate investments and, here in the Houston area where I live, that seems to be the prognosis for the foreseeable future as well.

The thing with buying vacant commercial land though is that it has no income. So, the trick is to buy commercial land that has some income being generated from maybe one corner of the land. This is what I try to do.

For probably the last 15 to 20 I read all the great investment books and did the whole Buffet / Benjamin Graham / Vanguard / ETF index investing thing and obediently added funds every year but the portfolios grew more by me adding cash than by themselves increasing in value. Even with dividends staying in.

I got tired of it all eventually and cashed in my ROTH and used the money to buy commercial real estate and commercial land instead. I started about 3 years ago with a small 3.2 Acre tract. This year I purchased a boat & rv storage business + the underlying 4.7 Acres and also another 5 Acre property that had a commercial building on one corner.

I have never been happier with my portfolios…. in about two years I’ve created close to $1M USD in new equity and in addition a very strong and growing cash flow to go with it. In fact, the cash flow in the next six months will grow to the equivalent of a 4% safe withdrawal rate from a mutual fund investment of about $1.8M USD.

So, not only did I create $1M USD in equity, the cash flow is like I have another $1.8 USD in the bank!!! And this cash-flow requires VERY little effort to maintain.

So, I doubt I will ever go back to stocks. In fact, now that my eyes have been opened to the incredible opportunities, in commercial land especially, I am looking to increase my investments in this area. The IRR projections on a new 7-Acre commercial land project I’m looking to undertake is 128% on some fairly conservative assumptions over a 3-year period. Try doing that in the stock market! :)

One of the key advantages of many commercial real estate income deals is that in many instances you can pass the property tax, building insurance & maintenance costs on to the tenant. This is one of the key reasons that commercial real estate investments will generally outperform a residential rental house investment.

I can guest post some of my deals with more detailed analysis if you are interested. I think it’s definitely something to look into. As William Penn famously said…. don’t wait to buy land, buy land and wait!

I’ve been looking at more commercial real estate investments lately with RealtyShares. They are a real estate crowdsourcing company based here in San Francisco. I invested my first $10,000 into a Conshy, Pennsylvania office property that will hopefully achieve a 12% – 18% IRR over the next five years.

A guest post on commercial real estate investing is intriguing. Let me know if you are up for it and what specifically you have in mind.

By the way, before I continue… my son’s name is Samuel & we call him Sam, Samuel or Sammy depending on the situation.

I was thinking of a guest post that would analyze in a little more detail some of the commercial deals I’ve done to contrast them to traditional residential real estate investments. Sort of a case study.

The Boat & RV Storage deal that I did earlier this year is a great one to look at:
– $650,000 = purchase price in Jan
– approx. 10% cap rate on date of purchase
– probably abt. $50k in upgrades
– increase rents by 40% to 50% after about four months
– property value increases to +-$950,000

I would provide initial projections & pro-forma along with updated IRR, cap rates based on today’s numbers. I only purchased the property in January of this year.

The other deal I’m looking at, the 7 Acre property… it has a small house on it being leased out for $1,000 per month. The rest of the land is covered in trees. However, it’s unrestricted so it can be used commercially. It’s close to a large airport (Bush International) and is on a 2-lanes each way road with a center turn-lane.

I believe the property can be easily converted into boat & rv storage with some parking also for 18-wheelers that are busy in the area due to the proximity to the airport and a large industrial manufacturing area.

The deal I’ve struck with the owners is to lease me the land for $1,000 per month for 12 months so it will give me the time to convert it to vehicle storage and then I can buy it in 12 months for $400,000 – they agreed to a purchase option for that price. By that time the income will be there to support the purchase. In the meantime I’ll be building the value of the property.

The projected IRR on this investment is, at the moment, 128% on a leveraged investment (20% deposits) or 36% on an all cash investment.

The business is fairly hands-off… my current boat & rv storage has no-one on site. Each tenant has a code to get through the gate and I only go there to sign a lease for a new tenant. Or to sweep out a vacant space if someone moves out. We don’t have a lot of turnover. Maybe once a month. We have 44 tenants & I’m adding two new buildings to add 16 more spaces so we’ll have 60 indoor tenants and I also have some outdoor tenants.

It’s nice to have 50+ tenants…. when you have 1 tenant the tenant has a lot of leverage. When you have 50 or more tenants, each tenant has very little leverage!

All this sounds very interesting and exciting, Lance! Personally I also prefer much more real estate than stocks etc, not only because I understand it better and feel I can be a better active investor (meaning I really choose what I invest in – as in where, what etc) as compared to stock where I’d have to be just passive adding money to the amount, rather than actively choosing good stocks as I do not feel confident, but also because I love the leverage that can be achieved, which increases your wealth in that much more.
Now these commercial real estate deals that you are talking about are very creative! I live in Australia and here investors can only borrow 50 to max 60% of purchase price for commercial vs 80 to 95% for residential, which offsets some of the better rental returns in my opinion, if you don’t have a big stash to start with.
Nonetheless, if there is a guest post by you on FS, I’ll make sure I pay very good attention to it!
And thank you to Sam for attracting such good readers and comments :)

I live in Los Angeles and make between 110-120k a year, my rent is only $1350 but goes up about 10% a year. Here it is at least 600-700 to buy a tiny fixer in an area I don’t even really like so I’ve been struggling if I should just make the plunge and get something, or keep renting and saving. Anything cheaper would add to my already horrendous commute.

I currently invest $1100 weekly into my Vanguard account, I plan on living in the area for at least 5-10 years, however I work in entertainment so things can change quickly, but I’ve been gainfully employed for as long as I’ve been here and keep about 25k in checking just in case of emergency. I’m really afraid that with my luck if I were to go for it, the economy will crash or we’ll have a giant earthquake not soon after and I’ll be stuck owning a 300k house with a 600k mortgage. Thanks for any words of wisdoms and thank you again for all your great writing!

Haven’t gotten any responses yet….so I can still expand the question. Considering doing such investments using a structure I learned about at https://www.401kcheckbook.com/ that enables me to invest retirement funds, but retirement funds are not something I want to take chances with. What are your thoughts? If it’s a good safe investment, then it would be ideal, but if not….

It’s incredible how timely your advice was in 2012 and how spot on your suggestion of investing in real estate was for your audience. I wonder how many people you influenced to make the plunge. I’m a real estate broker and real estate investor (on and off since 1986). The first building I purchased was in 1992 in the Bay Area, It was a 4 unit building I raised my 3 children in, but that is not the example I want to use because it was like buying Apple Stock, (too much luck) to use as an example. I want to share an example of a purchase I made in January 2014 at age 54 for a 4 unit apartment building in a rural area (along a main Interstate in CA) with your audience. The building had been on the market a long time at the price of $399,000. I paid $335,000 with a 20% down payment and a fixed interest rate loan of 5% (RE investment rate) The 4 rents for the 2 bed 2 bath units averaged 725 per month at the time of purchase. My Gross Scheduled Rents were 34,800 per year for the first 12 months. The Owner paid water and sewer for all 4 tenants. Expenses were about 15,000 year following my purchase and the mortgage payments (principal and interest) totaled 16,668 per year. The expense number includes a reserve account of $2,000 per year to be applied toward capital improvements such as roof and painting. Here are the updated numbers as of December 2018. Average rents are now 965 per month per unit. The Gross scheduled rents are 46,320 per year. The water and sewer are now separately metered and the tenants pay their own water charges. Separate water meters were put in on grant funding by the city municipality and I realize that was a lucky break (Each unit already had individual lines). My 2018 annual expenses are 11,800 per year. Annual Cash flow after owning this building 5 years is 17,852. The tenants are paying down my loan at approximately 420 per month which adds 5,040 to my annual return and I’m depreciating the asset (9,745 per year) So I’m saving about 3,500 on my taxes. These 4 units are not tough to manage, housing is in short supply and it is providing a annual financial benefit, after just 5 years, of 26,392. This purchase was not exceptional. My rents could be raised even further at this time. I believe the building would easily sell today for about $500,000. My initial investment was 67,000 down payment plus closing costs of 5,000 for total 72,000. My current mortgage balance is approximately $242,000. Thank you for your encouragement. What I have learned over the years. When 20% down payment on real estate gets you a break even or better cash flow on a real estate investment before taxes, or even a slight negative cash flow, the real estate market is at a bottom and it;s time to buy with both hands. The 4 plex example I mentioned above is one of 5 real estate investments I made during that period.

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